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Tax and Estate Consequences of Investing in U.S. Securities

As a Canadian resident you pay Canadian income on your worldwide income. Since Canada represents only a small percentage of the world markets, it makes sense that your portfolio includes some foreign securities. If you own U.S. securities such as issued by a U.S. corporation or real located in the U.S., you may also have to pay U.S. income and estate . It is important to note that even though some U.S. securities also on a Canadian exchange, those securities are still considered U.S. property and the withholding and estate tax rules will apply. However, there are ways to take advantage of reduced U.S. withholding taxes on certain securities, and general planning techniques to minimize your U.S. estate tax.

This article is written for Canadian residents investing Exemptions From Withholding Tax in U.S. securities and is not applicable to U.S. citizens As a result of the Treaty, U.S. source interest payments residing in Canada, U.S. residents (including Green (with certain exceptions, such as contingent interest) to Card holders) or Canadian citizens residing in the U.S., Canadian residents are not subject to any withholding since they face very different U.S. tax consequences. The tax. In addition, the Treaty provides an exemption information provided is general in nature and does not from U.S. tax for and interest earned in the take into account individual circumstances. Cross-border by arrangements operated exclusively to taxation and U.S. estate tax are both very complex issues. administer or provide pension, retirement or employee Accordingly, investors and potential investors should benefits. This means that dividends and interest earned consult their own independent professional tax advisors directly on U.S. securities held in an RRSP and RRIF will who specialize in these areas. generally be exempt from U.S. withholding tax. However, this exemption does not extend to U.S. source investment U.S. Withholding Tax on Dividends and income earned within a TFSA or RESP. Given the tax-free Interest Paid on U.S. Securities nature of a TFSA or RESP account, any withholding tax is The U.S. non-resident withholding is generally not recoverable as a foreign to the account (or 30 per cent. However, under the terms of the Canada- its owner). As such, this unrecoverable U.S. withholding U.S. Income (the “Treaty”), a Canadian tax represents a ‘cost’ in considering the viability of the resident individual will pay a lower withholding rate of investment in these accounts. 15 per cent on dividends, whereas interest payments are generally no longer subject to withholding tax. Canadian Tax on Dividends and Interest Paid At BMO Financial Group, withholding taxes are remitted on U.S. Securities directly to the Internal (IRS). The In taxable accounts, both dividends and interest from amounts withheld are reflected on all client account U.S. stocks and bonds or other U.S. are included in statements and slips. The dividends and calculating Canadian on a gross basis. interest received will be net of the U.S. withholding Where US withholding tax has been paid, Canada allows taxes paid (if any), and no further remittance to the U.S. a credit for the U.S. tax paid (or the proportion of your government is generally required. Canadian tax attributable to income from the U.S., if less) from your Canadian taxes otherwise payable. In addition, Tax and Estate Consequences of Investing in U.S. Securities

if the amount of U.S. tax paid for the year exceeds the U.S. Estate Tax Rates (in $U.S.) applicable Canadian tax, the excess U.S. tax may be If the taxable amount is: deductible from your Canadian taxable income. Tax rate on Over (1) But not over (2) Tax on (1) excess over (1) U.S. and Canadian Tax on Capital Gains From $0 $10,000 $0 18% U.S. Stocks or Bonds $10,000 $20,000 $1,800 20% $20,000 $40,000 $3,800 22% A Canadian resident is not generally subject to U.S. tax on gains from U.S. stocks or bonds unless the investor has a $40,000 $60,000 $8,200 24% greater than 5 per cent interest in a U.S. corporation, and $60,000 $80,000 $13,000 26% the U.S. corporation’s principal derived their value $80,000 $100,000 $18,200 28% from U.S. real estate; such as U.S. real estate companies or mining companies. $100,000 $150,000 $23,800 30%

Therefore, most capital gains realized on the sale of U.S. $150,000 $250,000 $38,800 32% stocks or bonds are taxable only in Canada. The taxable $250,000 $500,000 $70,800 34% (50 per cent of the actual capital gain) is $500,000 $750,000 $155,800 37% included in taxable income on your Canadian tax return. $750,000 $1,000,000 $248,800 39% Any foreign currency exchange gain or loss is also included in your Canadian taxable income calculation. $1,000,000 $345,800 40%

Source: Wolters Kluwer Limited, CCH U.S. Estate Taxes1 In Canada there is no estate tax or inheritance . The U.S. imposes an estate tax on all individuals, However, Canada does impose tax on unrealized capital including Canadian residents, who own certain U.S. gains at death by deeming the assets to be sold at their fair assets with a combined fair market value in excess of market value at the date of death2. This is applicable to all $60,000 at the time of their death. This is because all securities, including U.S. securities. The accrued capital non-resident ‘aliens’ of the U.S. are permitted an estate gain (or loss) is included as income on the deceased’s tax credit of $13,000 against the U.S. estate tax payable final Canadian income tax return. (which provides a shelter for up to $60,000 of taxable In contrast, U.S. estate tax is imposed on the fair U.S. property). From a typical Canadian perspective, market value of the property, rather than on the cost or U.S. assets include real property (such as a vacation appreciation of the property. As the chart above shows, property located in the U.S.), and stocks (or options to the tax rates for 2014 range from 18 to 40 per cent. acquire stocks) issued by a U.S. corporation, even if held in Canadian brokerage accounts; including RRSPs, For example, an estate with taxable U.S. property of RRIFs and TFSAs. $500,000 would attract $155,800 in estate taxes (based on the table above, using the graduated estate tax rates). An estate with taxable U.S. property of $650,000 would attract $211,300 in estate taxes, calculated as follows:

• Tax on the first $500,000 = $155,800 plus

• Tax on the next $150,000 at 37% = $55,500

Please note that the actual amount of U.S. estate tax payable may be lower due to certain credits available under the Treaty. Tax and Estate Consequences of Investing in U.S. Securities

Treaty Relief T he Treaty also specifies that a Canadian may be available in respect of U.S. estate The Treaty provides three very important forms of relief tax paid on U.S. stock options and U.S. securities against U.S. estate tax for Canadians that will reduce the held within an RRSP or RRIF to reduce the Canadian actual amount of estate tax payable. income tax otherwise payable as a result of death. • For U.S. tax purposes, a Canadian resident’s estate can However, a foreign tax credit is not available if the claim a portion of the unified credit available to U.S. RRSP or RRIF is transferred to a surviving spouse on a citizens against the estate taxes otherwise payable. tax-deferred basis. For deaths in 2014, the unified credit is $2,081,800 The deceased’s estate must file an estate tax return with (which equals the U.S. estate tax on $5.34 million of the Internal Revenue Service to report and pay any estate assets), prorated for the ratio of the value of U.S. assets tax for the year in which the death occurs. A return must compared to worldwide assets (expressed in U.S. be filed if the deceased owned U.S. property with a value dollars). As a result, Canadians with worldwide assets exceeding $60,000, even if as a result of the Treaty there is of less than $5.34 million should not have to pay U.S. no U.S. estate tax liability. The U.S. estate tax return must estate tax. Canadians with larger estates who hold only be filed to claim the benefits provided under the Treaty. a small portion of their wealth in U.S. assets will have access to a smaller fraction of the unified credit and may; therefore, have a large U.S. estate tax liability. U.S. Estate Tax Planning If you have U.S. , you should speak to your • An additional marital credit is available under the tax advisor about strategies available to minimize Treaty effectively doubling the unified credit where the your U.S. estate tax liability. Some of the more popular surviving spouse inherits the U.S. property. strategies include the following: Example • Holding U.S. securities in a Canadian corporation. U.S. investments owned by a Canadian corporation are not If the value of the worldwide assets is $10,000,000 of which $1,000,000 are taxable U.S. assets, the U.S. estate generally subject to U.S. estate tax. tax would be determined as follows: • Investing in Canadian mutual funds that invest in U.S. US Estate Tax on $1,000,000 $345,800 securities. • Transferring U.S. property to a surviving spouse Portion of Unified Credit: through a Qualifying Domestic Trust (QDOT) to defer ($2,081,800 x $1,000,000) $208,180 the payment of U.S. estate tax until the death of the $10,000,000 second spouse. In order for the Trust to qualify, an Net US Estate Tax: $137,620 individual who is a citizen of the United States or a U.S. corporation must serve as one of the trustees of In addition, a marital credit of $208,180 is available where the QDOT. a surviving spouse inherits the U.S. property. • Using ‘criss-cross’ spousal Trusts in the Wills to • Finally, a Canadian resident may be subject to both access the marital credit on the first death and reduce U.S. estate tax and Canadian income tax on accrued the value of U.S. assets and worldwide assets of the capital gains on the same U.S. property. The Treaty surviving spouse. provides that U.S. estate tax payable by Canadians can • An outright gift of U.S. stocks to family members will be claimed as a foreign tax credit on their Canadian reduce the taxable estate if made before death. There tax return for the year of death to reduce or eliminate is no U.S. imposed on the gift of stock of a U.S. the Canadian capital gains tax on the U.S. property that corporation from a non-U.S. person. was subject to U.S. estate tax. Member-Canadian Investor Protection Fund. Regulatory Member of theInvestment Organization ofCanada. Industry Note alsothatProvinces all and Territories (except for Quebec) imposeanestate administration tax (i.e., probate onthe value of anestate) • ® andBMOBMO InvestorLine NesbittBurnsInc. are Inc. wholly owned of subsidiariesof Montreal. Bank circumstances. choice for advice on your insurance needs, andseekindependent legaland/or tax advice on your personal position shouldbeobtained. You shouldconsult anindependent insurance broker or advisor of your own general innature for illustrative purposesonly. Professional advice regarding anindividual’s particular to belegaladvice or adefinitive analysis taxof applicability or trusts andestates law. Such comments are respect to any specific riskor insurance Comments includedinthispublication product. are not intended advice of ageneral nature andisnot to beconstrued asspecific advice to any particular person nor with reliable, butisnot guaranteed by us, may beincomplete, or may change without notice. Itisintended as herein reflects information available at thedate hereof. Itis based onsources that we believe to be BMO FinancialGroup provides this publication to clients for informational purposesonly. informationThe July 2014 2 1 • • Foreign investmentsinclude: during theyear. their aggregatecostexceedsCDN$100,000 atanytime to annuallyreportforeigninvestmentassetswhere securities istheCanadaRevenueAgency’srequirement Another issuetoconsiderwheninvestinginU.S. ForeignCanadian Reporting Requirements • Tax andEstate Consequences of Investing inU.S. Securities entitled BMO financialprofessionalforacopyofourpublication For moreinformationonU.S. estatetax,pleaseaskyour can beproven. owner the accountunlesscontributionsbysurviving account reduce U.S. estatetaxbecause whenaco-ownerofjoint However,survivorship. thisisnotaneffectivestrategyto spouses toholdassetsinjointownershipwithrightsof A popularstrategytoreduceCanadianprobatecostsisfor • transfer to aqualifying Subject at death to asurvivingspouseor trust. spousal All figures used to calculate U.S. estate tax are shown in U.S. dollars “BMO (M-bar roundel symbol)” isaregistered of of Montreal, Bank trade-mark usedunder licence. corporations (publicorprivate) Shares, bondsorothersecuritiesissuedbyforeign qualifying U.S. charity. Making an in-kind donation of U.S. assets to a included invaluingtheworldwideestate). not subjecttoU.S. estatetax (althoughtheproceedsare cover theU.S. estatetax.Life insuranceproceedsare Obtaining in an amount sufficient to (such asU.S. Treasury Bills) Debt offoreigngovernments Funds in foreign bank accounts dies, the U.S. deems that person to own 100% of U.S. EstateT ax forCanadians. • in penalties. or failuretodisclosetherelevantinformation,willresult within anRRSPorRRIF. Failure tofiletheformwhendue, The filingrequirementsdonotincludeinvestments • • opportunities mightbeavailable. foreign reportingrulesaffectthemandwhatplanning how incometaxes,U.S. estatetaxesandtheCanadian should consultwiththeirtaxadvisor(s)todetermine Investors withsignificantforeigninvestmentassets Conclusion BMO financialprofessional. For more information, speak with your •

limited partnerships Foreign trusts and partnerships, including Interests held in foreign rental Canadian corporationsbutheldoutsideCanada Shares, bonds or other securities issued by in Canada Certain mutual funds offered by foreign companies

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